Betting on Facebook’s future

Commentary: Valuing the social media IPO is tough amid frenzy

SAN FRANCISCO (MarketWatch) — With Facebook expected to become the most valuable U.S. company at the time of IPO when it goes public on Friday, there is no end to the frenzy around the deal.

As a result, it may be hard for many of Facebook’s
FB, +2.48%
901 million monthly users to sit out the IPO party. They may try and jump in sometime after the initial trading craze abates, or even in the days following its debut because it is one of the most anticipated IPOs ever.

“Facebook is like Halley’s Comet,” said Marty Wolf, president of Martin Wolf M&A Advisors, a San Ramon, Calif.-based firm that focuses on information technology. “This is like a religious event, maybe it’s tied into the economy.” Every time he watches the news, Wolf said, the breathless buoyancy over Facebook’s IPO is like it’s Mardi Gras.

But as investors will discover, trying to analyze whether the world’s largest social network merits its anticipated lofty valuation of $100 billion or more is going to be tricky. A lot of that market value will be based on the belief that the world’s largest social network will eventually use its treasure trove of user data to come up with a way to offer far more targeted advertising.

To put the $100 billion-plus market value in prospective, it’s worth pointing out that Amazon.com Inc.
AMZN, +2.01%
albeit in a different business, also has a market cap around $100 billion. But the e-commerce giant reported net sales of $48.08 billion in 2011, up 37%, excluding favorable currency impact. Facebook had 2011 revenue of $3.7 billion, with faster growth of 88% from 2010. Amazon is seen by the Street as highly valued. Facebook’s revenue growth is decelerating, as it did in its first quarter, with its revenue growth in 2012 projected at anywhere from 40% to 57%.

And it may get harder, at least in the short term, to accurately determine what Facebook is really worth, if its ups and downs with advertisers — where it gets the bulk of its current revenue stream — are put under a microscope. Facebook also gets revenue when customers buy Facebook credits to pay for virtual goods, such as hiring more cops for your city in Zynga’s CityVille game.

Advertising revenue and its potential, both on PCs and on mobile devices, will be a big driver for Facebook. Michael Pachter, an analyst with Wedbush Securities, explained the issue in his initiation report: “It is crystal clear that Facebook has a valuable asset in its large user base and that Facebook’s value is enhanced by the frequency and duration of the average visit,” he wrote. “Facebook has among the highest levels of engagement of any site on the Internet, yet it doesn’t monetize page views as well as many.”

That was highlighted on Wednesday, when auto giant General Motors Co.
GM, +0.69%
said it would no longer buy ads on the social network, but it would still maintain its company Facebook pages. It’s a small loss, of about $10 million in ad revenue, according to The Wall Street Journal, out of Facebook’s total 2011 revenue. But what was more potentially damaging was that GM said it did not find its ads on Facebook effective. Read more about Facebook's loss of GM.

Immediately after the news broke, there was a debate, including one among Facebook friends of course, on whether GM’s ads were the problem, or whether it was even the right match for Facebook. But the worrisome issue for investors is that others may follow, until Facebook figures out how to get its ads more targeted without irritating its users.

“It is entirely possible we will see more of that, unless their marketing products become more compelling and more measurably and demonstrably successful,” said Melissa Parrish, an analyst with Forrester Research. “I have talked to other marketers who have made that tough decision,” she added, declining to cite specific companies. “They don’t know how to make Facebook marketing work.”

Many analysts are looking further into the future as they calculate their estimates and price targets. Pachter, for example, started covering Facebook with an outperform rating with a 12-month price target of $44, which is based on a multiple of 26 times expected earnings of $2.00 a share in 2015.

“We think that given the huge upside potential for revenue and earnings growth, a $44 price target is warranted,” he said. “With that said, we think that investors should be prepared to be exceedingly patient.”

On the bearish side is Sam Hamadeh, CEO of PrivCo, which analyzes private companies. He believes the stock has a fair value at $24.59 a share, which is significantly lower than its current IPO price range of $34 to $38 and recommends a sell. Read about Facebook's latest price range.

As the company goes public and analysts employed at its huge army of underwriters start to write reports on the company, even more price targets and valuation analyses will emerge.

Investors are indeed going to need a lot of patience.

“I’d love to own it at the open,” said Wolf. “But long term, you have make a lot of assumptions.”

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